EM FX Weekly: After the storm
Head of FX Strategy, Saxo Bank Group
The chart below shows the sharp recovery in most EM currencies versus the USD as risk appetite rebounded in the aftermath of the equity market-centered volatility event. The ZAR remains a star performer as former president Zuma resigned. Keep an eye on the South African budget announcement this Wednesday for whether the rand can sustain this momentum as now the hard work for South Africa begins. Note that the Brazilian real is a bit of a laggard in the one-month time frame as President Temer struggles to reform the disastrous and unsustainable Brazilian pension system – a critical step for brightening the structural outlook for Brazil.
With the arrival of tighter capital controls in China in 2017, China continues to essentially just gets what it wants in terms of the exchange rate and it has wanted a stronger rate, possibly to avoid a lack of domestic confidence in the currency that was a problem in late 2015 and into 2016 and possibly with one eye abroad to avoid a confrontation with the US over trade issues. But from these levels, it is difficult to see why China wants its very strong currency to trade still stronger and any further deterioration in the USDCNY rate might be far more USD-driven rather than China-driven.
The structural issue for the yuan this year, which has not been priced in by the market, is clearly not linked to capital flight but rather to the risk of uptick in US-China trade tensions. Over the past weeks, the USA and China have taken a more aggressive stance on trade policy, threatening and counter-threatening after Trump’s team has circulated tariff ideas on steel and aluminium. An escalation cannot be ruled out and could see a very different stance on currency from China if Trump follows through on his threats.
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